Pledging Loophole

February 9, 2009

CROSSHAIRS (MoneyLIFE Issue, 26th Feb 09)

At the time of writing, investors were being shocked with daily revelations about the many promoters who have pledged their entire shareholding. These include Micro Ink, MRO TEK, Balaji Telefilms, Aban Offshore; others with significant pledge of promoter shareholding include Shree Renuka Sugars, Ganesh Housing, Nagarjuna Constructions, Asian Paints and Peninsula Land. Every time a brokerage firm released fresh information about such pledges, the company’s shares went into a tizzy and probably allowed some day-traders to make a killing. Is this the entire picture? And will SEBI’s (Securities and Exchange Board of India) reporting requirement force promoters to come clean on how much of their holding is pledged and for what purpose? The answer, say industrialists, is no. Promoters claim to have found two loopholes in the reporting system that allows them to not reveal the whole truth. They say that the SEBI circular, which requires a precise, six-part report in tabular form, still had an escape clause. It does not mention that shares held by a holding company of the promoter group, which are pledged to raise funds, must also be disclosed. This is, indeed, correct; but companies acting on this premise are clearly stretching the case to use it as a loophole, obviously advised by their legal experts. A holding company ought to fall under the definition of ‘promoter group’ and must obviously report the shares pledged by it. We also learn that promoters are striking deals with banks to hide their pledges by classifying them as ‘escrow’ of shares against borrowing. This too is splitting hairs, but companies may get away with it. The SEBI chairman, CB Bhave, is reported to have said, “If we get complaints that people are not complying with the regulation, we will investigate those complaints.” It remains to be seen if SEBI will really be open to market intelligence and crack down on a few such cases.

Satyam Drama

The Satyam case has now turned into a bizarre drama that is providing space for a host of bit players to clamber on to the stage and profit from the publicity. Meanwhile, Ramalinga Raju will probably go down in history as the man who fooled the largest number of people for the longest possible time while he committed India’s biggest corporate fraud (Rs7,800 crore and counting) and he didn’t even get caught – he confessed! Even better, for an entire month after he was arrested (that too only after public outrage), the Andhra Pradesh police and judiciary shielded him from interrogation by the capital market regulator. Like every corporate house in India, which has been fooling around with capital market manipulators, he has had plenty of time to ‘fix’ the system to ensure that he does not stand trial in the US, because the cases in India will probably last his lifetime as they slowly wind their way through various courts. In effect, once he gets bail, he will be virtually out of the woods.

Meanwhile, the beleaguered Satyam, which, until recently, was worried about how to pay staff salaries, has emerged as the hottest acquisition opportunity; nearly half a dozen buyers are in the race, without any assurance from the government that they will be ring-fenced from lawsuits and extraordinary liabilities. What makes this diverse set of companies so confident about Satyam’s potential? Do they know something that we don’t? Consider the bidders. There is Larsen & Toubro (L&T) which desperately mopped up Satyam shares without even waiting to get the lowest possible price. When the shares dropped further, it bought some more and claimed it was averaging its purchase price downwards while its stake rose beyond 12%. Or, was it making an ineffectual attempt to stem the decline? Why the indecent haste to take over a company without even assessing the full extent of its losses and liabilities? In fact, L&T’s purchase of Satyam shares, with the intention to acquire the company, has already triggered the takeover code. It cannot seek a post-facto exemption from the code, after first positioning itself in an advantageous position for acquisition. Has the board cleared these actions? Surely L&T shareholders need to ask some questions.

Phaneesh Murthy’s iGate Corporation is another bidder. Murthy was a star at Infosys until his exit under the cloud of a sexual harassment allegation. He probably sees the Satyam acquisition as a way to gatecrash into the IT (Information Technology) big league.

A third suitor is Dr BK Modi. His Spice Telecom was a creature of the bull market which was denied listing permission by the National Stock Exchange in 2007 because it had a negative networth in the pre-IPO period. Nobody knows the seriousness of Dr Modi’s bid, but Spice Telecom’s share price is witnessing extraordinary volatility. Is the regulator watching? Satyam’s other suitors include Hinduja Infosolutions, Tech Mahindra and Essar’s Aegis BPO. The good news is that the more the suitors, the less will be the demand for a government-guaranteed cap on the liability with the risk distributed to the general public who had nothing to do with Satyam.

Realty Bites

If you watch promoters of realty companies on television, they are busy telling you that prices have already bottomed out and investors are beginning to show interest in new acquisitions. This is false and misleading. In fact, banks are rigorously following ‘stage-linked disbursal’ agreements signed with the developers by refusing to release funds if they suspect diversion for other repayments. This is an important check which protects the customer as well as the bank. If the project is on stream, the bank’s only risk is that the borrower will default and, since the project is approved by the bank before disbursing a housing loan, it cannot wash its hands off if the developer fails to complete the project on time. Incidentally, a leading private bank says that consumers must ensure that they opt for ‘stage-linked disbursement’ for drawing down their loan, rather than time-linked mortgage, which it discourages. In situations like the present decline, it forces the developer to ensure project completion. Unfortunately, some investors are trapped in a time-bound payment where the bank is refusing to release payment (because progress is slow) while the builder is threatening legal action. One such borrower is Raj Damle (name changed) of Pune who took a Rs20 lakh loan for an apartment with Elpro builders. The bank decided that the project was not on schedule and held back further disbursement, leaving the borrower in a fix, because the builder, in turn, sent him a legal notice and levied interest on the balance amount. This extraordinary situation is on the way to being resolved after five months which is when the borrower wrote to us. But what happens to others in the same boat? In the absence of a much-needed real estate regulator, many borrowers are buffeted between a recalcitrant builder and an adamant lender. The government has the option of acting quickly by empowering the National Housing Bank to take on the role of a regulator to protect borrowers.